An equity market waiting to happen

Ukrainian equity issuance is down as global markets suffer, but bankers are confident that recovery is round the corner. London remains the listing destination of choice for big issues but the Warsaw exchange could prove a popular, and nearer, alternative to AIM for smaller deals. Robert Vielhaber reports.

The stillness in Ukraines equity capital market could well be the calm before the storm. "Ukraine is a market waiting to happen," says Sarah Williams, co-head of emerging Europe equity markets at UniCredit in London.

So far, the Ukraine has made up but a small part of the CIS equity capital market. In 2007, equity flotations from the country accounted for only 3% of the IPOs in the region, with six companies selling shares totalling $1.1bn.

These deals were overshadowed by multi-billion dollar transactions from Russia and Kazakhstan, such as those by Sberbank, VTB and Eurasian Natural Resources.

"The Ukraine is still a few years behind Russia in terms of companies getting their accounts ready for flotation," says another banker in London.

At least last year Ukrainian flotations made up in performance what they lacked in size. Newly listed Ukrainian companies gained 36% up to the end of last year, compared with a 13% gain on Russian IPOs and 10% from flotations in Kazakhstan.

Although stockmarkets have had a tougher year this year, the data shows it would be a mistake to underestimate the Ukraines equity market.

"This year will be a strong year for Ukrainian equity capital markets. A number of companies have plans to do an IPO or an equity market transaction," says Fran Kucera, head of capital markets for central and eastern Europe at Linklaters in Kiev. "The sentiment is still positive and strong, even if some deals that would have been done this year may be postponed to the first half of next year."

So far, businesses from a variety sectors have made their IPO plans known and some reports even estimate the number of enterprises ready for a public offering at around 80.

Many of them are out to break the Ukrainian IPO record set by iron ore producer Ferrexpo in its $426m London flotation in June 2007.

One candidate is Interpipe, a maker of large diameter pipes, which wants to raise as much as $1bn in a London listing. The deal is set to be brought to market this year by Deutsche Bank, RBS-ABN Amro and Merrill Lynch.

"At the price Interpipe is trading at it would probably be a bit too expensive for investors. At their current p/e ratio, they could get away in a good market, but I am not certain if people would accept that right now," says Lucas Romriell, head of equities at Galt & Taggart Securities in Kiev.

TV company Inter Media Group hopes to garner as much as $500m.

The latest Ukrainian company to approach the market is Myronivsky Hliboproduct (MHP), a foods group that specialises in chicken farming, which in late April was planning to raise as much as $400m through a London GDR sale led by Morgan Stanley and UBS.

The early part of 2008 has not been an ideal time to bring equity sales to the market, anywhere in the world. Many markets have fallen and investors have spent much of the year clinging to cash.

Two exchanges are established in Kiev, the larger First Stock Trading System (PFTS) and the Ukrainian Stock Exchange. However, at daily trading volumes of $30m-$60m for PFTS, its attractiveness for foreign investors is limited.

The PFTS index has lost 26.3% this year so far. It reached a five year high on January 15, but has been spiralling downwards since then.

But Kucera is confident investors have not lost interest in Ukraine particularly. "These issues dont have anything to do with the business of the company itself or with the Ukrainian market, they are just down to the global investment climate," he says. "The key issue with transactions like those for Inter Media Group and Interpipe is that there is no real pressing desire for the owner to sell down a holding."

Bankers that work in the Ukrainian market expect the steel, mining and banking sectors to dominate initial public offerings this year. But the MHP sale also highlights the growing importance of the agricultural sector in the Ukraine, which was dubbed Russias bread basket in Soviet times.

"With rising food and soft commodity prices, the agricultural sector is clearly a focus for investors at the moment and there is a good pipeline of deals coming through," says Williams at UniCredit.

Other deals slated for this year include one from financial and industrial group System Capital Management, which plans to float some of its business units, such as its energy group. But System Capital, like many owners in the Ukraine, is not cash-strapped and if it cannot get the right valuation, then it is likely to postpone any offer.

What is unusual for an economy like Ukraine is that most IPO candidates are privately owned companies rather than state companies.

Ukraines privatisation process has come to a standstill, as a result of the delicate balance in parliament between conservatives and liberals which makes legislation a slow process.

Deals from state-owned companies such as Ukrtelecom, the national telecommunications operator, or national savings bank Oschadbank are therefore little more than rumours.

"For the last couple of years people have been looking at potential privatisation deals from the telecom and railways sectors, for example, but I dont think that there is a stable political background for those sorts of deals to go ahead successfully," says Kucera.

The equity capital market is consequently a private-to-private market in which shareholding groups and oligarchs look to shed or reduce their stakes. And if there is no pressing desire for the owners to sell and the companies are not in need of capital, they will wait for an IPO and do debt funding instead.

Commodity prices drive economy

Last years record flotation by Ferrexpo typifies Ukraines equity markets and general economy, for which food, minerals and metals are the main drivers at 65% of total exports in 2006.

However, the OECD warns that that Ukraines main exports, which are concentrated on goods with a low degree of processing, are energy-intensive. What makes matters worse is that the country depends on Russia for three quarters of its annual oil and natural gas requirement.

Furthermore, a lack of structural reform has made Ukraine vulnerable to external shocks. The International Monetary Fund has therefore encouraged the country to quicken the pace and scope of reforms.

However, Ukraines economy remains buoyant. GDP growth reached 7% in 2006 and 2007, fuelled by high prices for steel, the countrys primary export. Growth was also stimulated by domestic consumption as pensions and wages rose. The 46m population now includes a big middle class. As disposable income has increased, so has demand for home ownership and retail spending.

Is Warsaw the new London?

The Ukraine depends on outsiders for its economy to function, whether it is through goods exported or energy imported.

This foreign dependency also applies to the equity investor base and preferred listing venues. Most of the Ukrainian companies that go public list in London and there are no signs of the local stockmarket offering serious competition for large deals. For enterprises that want to interact with a wider international investor base, London is the way to go.

"International investors are not ready to take trading, execution and liquidity risk in the Ukrainian exchanges. They will look at the London market as the main market," says Kucera.

At the same time, bankers and traders acknowledge that other exchanges are trying to snatch the lead from London, with Warsaw in particular challenging LSEs dominance.

Commentators predict a host of smaller deals from the Ukraine. For those transactions, with a size of $200m-$300m, Warsaw will be an appropriate market, particularly for businesses in consumer-driven sectors.

"A small number of deals justify a London listing," says Williams. "For the usual small-fish-big-sea type of argument, others are sensibly considering markets such as Warsaw."

"We have spoken to some of our clients and they have said they would like to list in Warsaw rather than in London. Their rationale is that if you are a smaller company in London, you might attract less investor interest," agrees Kucera.

One recent example is Kernel, an agricultural company that produces edible oils. It raised $218m by selling a 33% stake on the Warsaw exchange in November.

Romriell, however, disagrees that there is a trend to list in Warsaw. "Up to now only two [Ukrainian] companies are listed there. The trend is listing abroad, whether that is in Warsaw, London or even Frankfurt," says Romriell.

The main argument for Warsaw, along with its geographical proximity to the Ukraine, is that typically there is no retail market for GDR offerings in London, which are by nature tailored towards specialist investors. In Poland, most equity offerings are public and meet a vibrant retail market.

Furthermore, Polish investment funds are desperate to diversify their holdings, and are therefore attracted to foreign companies listing in Warsaw. By contrast, the latest IPO and GDR listing in London by MHP is aimed only at institutional investors.

However, the Warsaw stockmarket has faced the same difficulties as other markets. It has fallen sharply this year and sellers target valuations have become tougher to achieve. The main index of the Warsaw exchange, the WIG 20, has lost 14.4% so far this year, having fallen 17% in mid-January, when it hit a low of 2,799.

"The chances of Warsaw attracting more IPOs is good, but I dont think that AIM [Londons Alternative Investment Market] is going to lose its crown any time soon," says Romriell. "It is a pretty well established market."